Hubei Huarong Holding Co.,Ltd. (SHSE:600421) shareholders that were waiting for something to happen have been dealt a blow with a 33% share price drop in the last month. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 38% share price drop.

Even after such a large drop in price, given around half the companies in China's Trade Distributors industry have price-to-sales ratios (or "P/S") below 0.6x, you may still consider Hubei Huarong HoldingLtd as a stock to avoid entirely with its 10.5x P/S ratio. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

How Hubei Huarong HoldingLtd Has Been Performing

Revenue has risen firmly for Hubei Huarong HoldingLtd recently, which is pleasing to see. It might be that many expect the respectable revenue performance to beat most other companies over the coming period, which has increased investors' willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Do Revenue Forecasts Match The High P/S Ratio?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Hubei Huarong HoldingLtd's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 18% gain to the company's top line. The latest three year period has also seen an excellent 32% overall rise in revenue, aided by its short-term performance. So we can start by confirming that the company has done a great job of growing revenue over that time.

This is in contrast to the rest of the industry, which is expected to grow by 17% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that Hubei Huarong HoldingLtd is trading at a P/S higher than the industry. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh heavily on the share price eventually.

What Does Hubei Huarong HoldingLtd's P/S Mean For Investors?

A significant share price dive has done very little to deflate Hubei Huarong HoldingLtd's very lofty P/S. We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

The fact that Hubei Huarong HoldingLtd currently trades on a higher P/S relative to the industry is an oddity, since its recent three-year growth is lower than the wider industry forecast. When we see slower than industry revenue growth but an elevated P/S, there's considerable risk of the share price declining, sending the P/S lower. Unless there is a significant improvement in the company's medium-term performance, it will be difficult to prevent the P/S ratio from declining to a more reasonable level.

You should always think about risks. Case in point, we've spotted 3 warning signs for Hubei Huarong HoldingLtd you should be aware of, and 2 of them make us uncomfortable.

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.